China may struggle to cap ‘Total Social Financing’

Controlling debt apart from bank loans tricky, but essential

By

HuoKan

BEIJING (Caixin Online) — The central government has said it would keep the growth of bank loans and total social financing steady this year. But its control over total financing has weakened because the share of bank loans in Total Social Financing (TSF) has declined.

That means it would be very difficult to keep the growth of the money supply at a modest level.

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The bank had wanted to keep the growth of TSF at a “reasonable” level in 2012. It turned out, however, that it reached 22.8% year on year, with a total of 15.76 trillion yuan ($2.53 trillion). The rate exceeded that for the same year’s yuan bank loans by 7.8 percentage points.

Many economists said they were surprised at the fast expansion of TSF, especially the significant increase in non-bank lending through financial instruments such as enterprise bonds and trust products.

The share of bank loans in TSF fell from 91.9% in 2002 to 52.1% in 2012. Particularly in the last four months, the ratio on average was less than 40%. In December, it was only 28%.

On the surface, the trend fits the goal of financial reforms to reduce the economy’s excessive reliance on bank loans.

Closer scrutiny of the factors that drove non-bank lending and where the money was spent reveals, however, that the change could be breeding new risks.

Many trusts and enterprise bonds were tied to local government financing platforms. Despite being shaped like a free market tool, they were in effect backed by local governments or even the central government, and all market participants know that. This means the pricing of these products didn’t properly factor in the risk of the underlying projects.

Among non-bank financing tools, enterprise bonds and trust products were very popular. The ratios of enterprise bonds and trust loans in TSF rose to 14.3% and 8.2% in 2012, up from the previous year’s 10.6% and 1.6%. Both figures were the highest since 2002.

Many trusts and enterprise bonds were tied to local government financing platforms. Despite being shaped like a free market tool, they were in effect backed by local governments or even the central government, and all market participants know that.

This means the pricing of these products didn’t properly factor in the risk of the underlying projects.

This is the first year for the new central government leadership and many administrations at local levels. The timing coupled with the launch of urbanization strategy has driven many local governments into another expected investment binge.

Many have been preparing for months new projects, many of which are already in the pipeline for regulators to approve. They would need huge amounts of money to pay for those projects and to repay old debts.

But it may be unwise for TSF to keep rising fast as it did last year. The problem is the central bank has little power over the issue even if it wants to curb the growth.

Many non-bank financing channels, including enterprise bonds and trust products, aren’t directly regulated by the central bank. The only way the bank can exert some influence is by adjusting liquidity in the inter-bank market, thus affecting interest rates and the cost of using bonds or trusts to raise money.

A joint policy issued by four central government agencies in December was aimed at restraining local governments from borrowing through non-bank channels. But it is still too early to see its real effectiveness.

Calls have been raised from multiple sectors that bank lending should be relaxed to relieve the real economy of liquidity pressure. Some trust analysts said either bank loans or non-bank lending must be increased.

The amount of yuan bank loans in 2012 was 8.2 trillion yuan. If its ratio in the total remains unchanged this year, a 9 trillion yuan bank loan target means the TSF would reach 17.3 trillion yuan, or roughly 30% of gross domestic product.

Assuming the TSF grows faster than in the above scenario, at 20% year on year, the figure this year would be 18.9 trillion yuan, or 33% of GDP. By contrast, the highest ratio before 2009 was only 25%.

The challenge is even tougher when taking into account non-bank financing channels that aren’t included in TSF.

For example, many local government financing platforms borrow through privately-offered funds or securities firms. That part of financing has been largely untracked, but it would add to the total money supply in the market.

Therefore, it would be wise to keep TSF from expanding too fast. Failure to do so means we will soon rush into a quagmire with problems ranging from high inflation to still heavier debt burden.

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